As fiduciaries, executors and trustees owe numerous duties to both the estate and to its beneficiaries. This article addresses a particular trustee duty, namely the duty to invest the trust property.

1. A trustee is required to obey the trust deed

Often, a trust deed will contain a specific term limiting the trustee’s investment authority. Recently, the British Columbia court provided a clear message to settlors and testators to carefully consider the words chosen in a trust deed, as those words may greatly limit the trust investments. In Dunn v. TD Canada Trust (2016), a trust created upon the death of the testator in 1957 contained a clause directing the trustee to “retain in the form in which they are at the time of my death all my investments in bonds and stocks, and to sell, call in and convert into money all the rest and remainder of my estate.” Between 1957 and 1973 the trustee sold most of the original investments, including the stocks and bonds. Most of the cash realized from these sales was distributed to the beneficiaries. What remained in the trust was invested in blue chip stocks and various bonds.

However, despite the fact the beneficiaries had received most of the cash and the remaining investments were prudent, the court found the trustee had breached its duty to obey the trust deed. Clearly, a trustee and a trust’s investment advisor must carefully read and adhere to the words used in the deed.

In 2017, the Court of Appeal reversed the trial court’s decision based on an interpretation of the clause in the Will. However, the principles set out by the trial court are still applicable.

2. A trustee is obligated to invest as would a prudent investor

To ensure the investments of a trust are “prudent,” a trustee is required to consider, among other factors, the following:

• General economic conditions
• The possible effect of inflation or deflation
• The expected tax implications of investment decisions on the overall investment strategy
• The role each investment plays in the trust’s portfolio
• The expected total return from income and appreciated capital
• The need for liquidity, any required income payments and the preservation or appreciation of capital
• Any assets of special value to the beneficiaries.

In addition, case law is clear that a trustee has an obligation to diversify the trust’s portfolio to the extent it is appropriate, even in those provinces where the legislation does not require diversification.

In most instances, a trustee is required to establish and follow an investment plan assessing the risks and returns associated with the investment portfolio. Trustees should ensure they obtain advice from an advisor and review this plan on an annual basis or when circumstances change. Failure to establish and follow a plan may result in personal liability for the trustee.

In all provinces, a trustee is permitted to delegate investment authority to an investment advisor, so long as the choice of advisor is prudent. A clause in a trust deed or Will that is becoming more common provides a direction to the trustee to retain a specific advisor so long as that choice is prudent when retained. This ensures some continuity, as the advisor named is often the individual who provided services to the testator or the settlor before the trust was created.

Where the trustee delegates authority to an advisor, a written agreement between the trustee and the advisor, in addition to the investment plan, is required.

Given the requirement for diversification, the use of mutual funds are ideal for investing in trusts. Provincial legislation specifically authorizes a trustee to use mutual funds when investing in a trust. However, an investment advisor retained by the trustee will want to see specific authorization to use funds in the trust deed. In the 1994 Ontario case of Haslam v. Haslam, the court held that although delegation by a trustee to an investment advisor was authorized, this did not authorize the investment advisor to sub-delegate to anyone else, including a mutual fund management company without specific authorization in the deed. To remove any uncertainty a well-drafted trust deed authorizing the investment advisor to use mutual funds when investing.

It is also important for a settlor or testator to ensure that the terms of the trust deed are broad enough to allow for the type of investments they feel would be most beneficial. For instance, if the settlor or trustee contemplates the use of a mutual fund with a return of capital component, it is advantageous to allow the income beneficiary some ability to encroach upon capital; otherwise, additional steps will be required in the trust accounting.

3. A trustee is obligated to maintain an even hand between the beneficiaries

A trust will often have two different classes of beneficiaries with competing interests. An income beneficiary is the person or persons who have the right to access the income produced by the trust.

Often the income beneficiary may encroach upon the capital in some circumstances. Capital beneficiaries are the persons who will inherit the capital of the trust when the trust is terminated.

In some trusts the settlor or testator will include a specific clause directing the trustee to prefer one class of beneficiary or even to ignore the interests of one class of beneficiary, thereby freeing the trustee from the confines of the “even hand” rule. However, in the absence of such a clause a trustee must ensure that the interests of all beneficiaries, both income and capital, are considered when investing.
These legal rules should be kept in mind both when creating and when administering a trust. Failure to consider these rules when drafting a trust will inhibit the trust’s investment advisor. Failure to consider these rules during the trust’s administration will lead to potential liability.

In Part 1 of the articles, I highlighted the importance of choosing a benefactor for your TFSA and the tax outcome with each type. I will continue with the three remaining methods of how to transfer your TFSA upon death.

Designation of an “Exempt Contribution” by a surviving Spouse/Common-Law Partner who Inherits the Spouse’s TFSA by Bequest.

Another case is where a spouse or common-law partner has not been designated as successor holder or as beneficiary of the spouse’s TFSA, but instead inherits the TFSA from the spouse in a Will. In such a case, the surviving spouse also has the option to contribute and designate all or a portion of the payment as an “exempt contribution” to their own TFSA.

This is true regardless of the holder’s province of residence, but will be especially true in Quebec, in most cases, given that the designation of a successor holder and of a beneficiary is currently only allowed if the TFSA is linked to an annuity contract or insurance policy (segregated funds).

Let us take the case of Julie, who lives in Quebec. Julie is the holder of a TFSA, which she bequeaths in her Will to her husband, Luc. Julie dies at which time the value of her TFSA is $45,000. Income of $1,000 has accrued in the TFSA account since the date of death until the time when the full amount of the TFSA, $46,000, is paid to Luc…

The value of the TFSA of $45,000 at the date of death is not taxable. However, the income of $1,000 earned after the date of death is taxable. This amount of $1,000 is to be included in Julie’s estate but will ultimately be taxed in Luc’s hands under regular trust taxation rules. Luc can contribute the $45,000 to his own TFSA during the rollover period, treat this contribution as an “exempt contribution” by filing form RC240 with the CRA within 30 days following the contribution date. The contribution will have no effect on his unused contribution room. If Luc wanted to contribute all or a portion of the income of $1,000, he received to his own TFSA, this would reduce his contribution room by the same amount.

Designation of an “Exempt Contribution” by surviving Spouse/Common-Law Partner through Intestate Succession.

A spouse may also receive the TFSA following the death of their spouse through the settlement of an intestate succession. In such a case, the surviving spouse also has the option of contributing and designating all or part of the payment received as an “exempt contribution” to their own TFSA, subject to their succession rights and provided that the contribution to their TFSA is made during the rollover period and that form RC240 is filed within the specified time.

Designation of an “exempt contribution” when the transfer of amounts from a deceased spouse’s TFSA is made to satisfy the bequest of a sum of money provided in the Will in favour of a surviving spouse or common-law partner.

It should not be concluded that because a Will does not specifically provide for the bequest of the TFSA in favour of the surviving spouse that the latter may not designate a contribution made to his TFSA as an “exempt contribution” after the death of the spouse. This is in fact what was confirmed in Technical Interpretation 2016-0679751E5 issued by tax authorities on May 11, 2017.

The question asked to the CRA involved determining whether the transfer by the legal representative of the estate (executor/liquidator) of amounts from a deceased TFSA holder to his surviving spouse, to satisfy a specific bequest of a sum of money provided in the Will, meets the definition of “exempt contribution,” if the surviving spouse were to subsequently use the amounts to contribute to her own TFSA.

Such a situation can occur, for instance, when the following facts are found:

Pierre died and was notably the holder of a TFSA in the amount of $45,000. No successor holder was designated for the TFSA and there was no designation of a beneficiary.

Pierre’s Will provided for a specific bequest of $45,000 to his spouse, Christine, and a bequest of the remainder of all his other assets to his daughter, Nicole. Although Pierre’s Will did not provide for a bequest of the TFSA in favour of his spouse, the legal representative of the estate (executor/liquidator), Nicole, agreed to transfer the value of the TFSA in the amount of $45,000 to Christine, the surviving spouse, to satisfy the specific bequest of an amount of $45,000 made by Pierre in favour of Christine under the terms of the Will.

Deceased’s unused contribution room

No contributions may be made to a taxpayer’s TFSA after their death even if contribution room is available. Contrary to an RRSP, where the legal representative of the estate is allowed to contribute to the decease’s RRSP to offset taxes, any unused contribution room when a TFSA holder dies is lost.

However, when death is imminent and a TFSA holder will be leaving a spouse behind, it may be beneficial to take advantage of unused contribution room by contributing the maximum amount to the TFSA before the holder’s death. The surviving spouse will receive a larger [“exempt contribution”] amount which could offset any OAS claw back.

Properly designating the benefactor of your TFSA as a successor annuitant, beneficiary or through a Will is paramount to avoid any unnecessary administrative work for the legal representative of the decease’s estate. Make sure you understand the facts before proceeding.

The introduction of the Tax-Free Savings Account (TFSA) from the Conservative government in 2009 provided all Canadians with the opportunity to accumulate monies tax-sheltered and tax-free upon withdrawal. It can be a great source of tax-free retirement income preventing or minimizing the Old Age Security (OAS) claw back. To maintain the inherent tax-free benefits of the TFSA, the annuitant needs to ensure they have properly designated the benefactor of the account.

The methods of transferring one’s TFSA to a benefactor has created complexities. This is Part 1 of 2 in understanding how to protect your legacy.

When the holder of a TFSA dies, the income and gain in value accrued up to the date of death are not taxable. However, the income and gain in value accrued in the TFSA after the date of death are taxable, except if the surviving spouse/common-law partner has been designated as successor holder, not beneficiary.

Designation of Spouse/Common-law Partner as Successor Holder

Only a spouse or common-law partner can be designated as successor holder in a TFSA contract or Will. In this respect, the surviving spouse becomes the new TFSA holder as soon as the initial holder dies. This is an optimal method since it is the only way for the income and gains earned in the TFSA after the date of death to be tax-exempt. In addition, after the death of the initial TFSA holder, such a designation will not affect the surviving spouse’s unused contribution room.

However, for TFSA holders in Quebec, the designation of successor holder is currently only allowed if the TFSA is tied to an insurance policy or annuity contract, such as segregated funds. At present, most TFSAs in Quebec do not allow the designation of a successor holder.

Let us look at the case of Jennifer, who lives in Ontario. Jennifer is the holder of a TFSA and has designated her spouse, Carl, as successor holder. Jennifer dies at which time the value of her TFSA is $45,000. Income of $1,000 has accrued in the TFSA since the date of death.

Carl has become the new holder of Jennifer’s TFSA. Neither the value of the TFSA of $45,000 at the date of death or the income of $1,000 earned after the date of death is taxable. In such a case, Form RC240, “Designation of an Exempt Contribution Tax-Free Savings Account (TFSA),” does not have to be submitted.

Designation of Beneficiary other than Spouse/Common-Law Partner

If, instead, a beneficiary was designated in the TFSA contract or Will, the income and gains accrued up to the date of death are also tax-exempt. However, the income and gains earned after the date of death are taxable for the beneficiary.

Let us take the case of Denise, who lives in Ontario and is the holder of a TFSA. Denise designated her son, Pierre, as the beneficiary for her TFSA. Denise dies at which time the value of her TFSA is $45,000. Income of $1,000 has accrued since the date of death and the full amount of the TFSA, $46,000, is paid to Pierre…

The value of the TFSA of $45,000 at the date of death is not taxable. The income of $1,000 earned after the date of death is taxable for Pierre. The latter may use all or part of the funds he has received to contribute to his own TFSA, provided he has unused contribution room.

Bequest TFSA to Legatee other than the Spouse/Common-Law Partner

The bequest of a TFSA in a Will to a legatee other than the spouse or common-law partner will have the same tax implications as those indicated above, regardless of the TFSA holder’s province of residence at the time of death.

In Quebec, in most cases, given that the designation of a beneficiary is currently only allowed if the TFSA is tied to an annuity contract or insurance policy, the transfer of a TFSA at death will generally be done through a bequest in the Will.

Let us go back to the case of Denise if she lives in Quebec. Denise is the holder of a TFSA, which she bequeathed in her Will to her son, Pierre. Denise dies at which time the value of her TFSA is $45,000. Her estate is settled at which time income of $1,000 has accrued and the full amount of the account, $46,000, is paid to Pierre.

The value of the TFSA of $45,000 at the date of death is not taxable. The income of $1,000 earned after the date of death is taxable. This amount of $1,000 is to be included in Denise’s estate but will ultimately be taxed in Pierre’s hands under regular trust taxation rules. Pierre may use all or part of the funds he has received to contribute to his own TFSA, provided he has unused contribution room.

Designation of an “Exempt Contribution”¹ by Surviving Spouse/Common-Law Partner

A surviving spouse or common-law partner designated as the successor holder of the spouse’s TFSA has the option to contribute and designate all or a portion of the payment as an “exempt contribution” to their own TFSA. Doing so has the advantage of not affecting their unused contribution room. However, the following conditions must be met for a contribution to qualify as an “exempt contribution”:

• An amount paid out directly or indirectly [through a Will] of an arrangement that ceased to be a TFSA upon the death of its holder must be made to the surviving spouse/common-law partner following the holder’s death.
• A contribution is made by the surviving spouse to their own TFSA by December 31 of the calendar year that follows the year of death (rollover period).
• The surviving spouse is not required to fill out form RC240, “Designation of an Exempt Contribution Tax-Free Savings Account (TFSA),” since he/she was classified as successor annuitant. If the designation was classified as beneficiary, then the surviving spouse must complete RC240 and send it to tax authorities within 30 days after the day of the contribution to their own TFSA account and
• The amount of the “exempt contribution” must not exceed the fair market value of the TFSA at the time of death.

Julie, who lives in Ontario is the holder of a TFSA and has designated her spouse, Luc, as the beneficiary not successor annuitant. Denise dies and the value of her TFSA is $45,000. Income of $1,000 has accrued since the date of death until the time when the full amount of the TFSA, $46,000, is paid to Luc.

The value of the TFSA of $45,000 at the date of death is not taxable. However, the income of $1,000 earned after the date of death is taxable for Luc. Luc contributes $45,000 to his TFSA. Given that Luc has contributed the amount of $45,000 to his own TFSA during the rollover period, he can treat this contribution as an “exempt contribution” by filing form RC240 with the CRA within 30 days following the contribution date. Such an “exempt contribution” will thus have no effect on Luc’s unused contribution room. If Luc wanted to contribute all or a portion of the income of $1,000, he received to his own TFSA, this would reduce his contribution room by the same amount.

Designating the benefactor of an TFSA as a successor annuitant, beneficiary or through a Will has its own set of tax rules. In order to fulfill your estate plans, its important to understand the guidelines and how your designation will be administered by CRA. Make sure you understand the facts before proceeding.

In Part 2, I will discuss the transfer of an TFSA by bequest and intestate succession along with unused contribution room of the deceased.

From Jan. 1, 2015 various changes relating to the Estate Administration Tax Act have become effective. While these changes seem administrative in nature, a deeper look reveals they can make estate administration and the probate process more onerous, costly and time-consuming. This makes it critical for Ontario residents to carefully plan their financial affairs to minimize or avoid estate administration tax. This article discusses the changes and their impact for executors/trustees.

The changes

1. Duty to give information

This change requires anyone applying for (i) the grant of probate, administration or testamentary guardianship or (ii) a certificate of appointment of estate trustee, from the Ontario court, to provide such information about the deceased person as may be required by the Minister of Finance. The information must be provided within the time and in the manner as may be prescribed by the Minister. The estate representative is also required to provide all reasonable assistance, and answer all questions, during a subsequent audit. Third parties are also required to provide the required information to the Minister.

2. Assessments and re-assessments

This change gives powers to the Minister of Revenue to assess or reassess the estate in respect of the tax payable. Generally, the Minster may assess or reassess the estate within four years after the day the tax became payable. There is no time limit if the person has failed to provide the information required or made a misrepresentation.

3. Audit and inspection

This change authorizes the Minister of Revenue to appoint inspectors to exercise the powers and perform the duties under the Estate Administration Tax Act.

4. Offences

This change makes failure to provide the information, or providing false or misleading information, an offence punishable by fine, imprisonment or both. The minimum fine is $1,000, and maximum is twice the tax payable. The term of imprisonment may be up to two years.

The impact

While these changes seem simple, the impact can be far reaching.

The “duty to give information” in and of itself doesn’t appear burdensome. However, when it’s read with the increased power of assessment/reassessment and penalties, it’s clear that much more effort and due diligence is required by the person applying for probate or certificate of appointment of estate trustee. The inventory of the estate assets and their values are to be provided to the Minister. It’s now more important than ever the applicant ensures all the assets are reported and proper valuations are done. Depending on the valuation issues and financial affairs of the deceased, it may require significant time before the application is made to the Ontario court for probate or certificate of appointment of estate trustee. In many cases, no distribution of the estate may be possible without probate or the certificate of appointment of the trustee, resulting in delay in administering the estate.

The enhanced audit and verification powers means the Minister may review the asset valuations. What if the valuation is higher – resulting in increased estate administration tax liability, but all the assets of the estate are already distributed? As mentioned, the Minister may assess or reassess within four years, so there is a possibility an auditor may come back on the estate trustee. Does this mean trustees should wait for at least four years before distributing all the assets of the estate? If so, this further adds to delay in estate administration. If not, the trustee may be assuming   the uncertainty and risk.

The solution

A very simple solution is provided in the Estate Administration Tax Act itself – i.e., no tax is payable if the value of the estate does not exceed $1,000.

Obviously, this solution does not apply to most individuals, and highlights the need for estate planning.

Different planning opportunities such as an alter ego trust or joint tenancy for the ownership of property (particularly for spouses or common-law partners) etc. are available to transfer the assets outside of one’s estate, thereby minimizing the estate and resulting estate administration tax.

Each opportunity has its own complexities and may require annual maintenance costs, not to mention potential income tax consequences.

The inspiration for this article came from a friend, an incorporated physician and director of a prominent downtown clinic.

The last time I visited him, the topic of tax efficiency and pensions came up. I asked if he paid into CPP. He confidently claimed that he did not and explained that he drew all his income in the form of dividends paying less tax and avoiding the obligation of having to make both the employer and employee contribution to CPP.

His overly self-assured claim of this strategy’s superiority triggered my curiosity. Is it truly better for a business owner or incorporated professional to draw all their income in the form of dividends?

Dividends with No Salary Avoids CPP Contribution, But at What Cost?

At first glance, the answer seems obvious. Only taking dividends avoids having to make CPP contributions (10.2% of net income for incorporated individuals up to a maximum of $5,497.80 in 2019). This can look attractive, if all the income is spent, since there is more to spend.

Some day, we all will either die at work or retire. The latter is the preferred option for most. The more you save and build wealth, the more comfortable your retirement will be. In an increasingly competitive world where technology is disrupting many business models, business owners and incorporated professionals cannot rely upon the sale of their business to fund their retirement. So, there should be a plan in place to build wealth outside the business.

Established strategies may need to be rethought. Recent changes to the income tax act with the new passive income rules have made it less attractive to transfer money to a holding company via tax free dividend and invest within the holding company.

The Financial Model Illustrates the Potential Opportunity Cost of a Dividend Only Strategy

Two scenarios for a 45-year-old incorporated professional with $250,000 of net business income (before salary or dividends) were examined. Under scenario 1, all income flows out as a dividend. Scenario 2 uses a mix of salary and dividends.

The analysis used one year of income to calculate the impact on disposable income, total funds invested, taxes paid and the future value of the invested funds in 20 years. Both scenarios assume lifestyle expenses of $125,000. All funds in excess of lifestyle expenses are invested with a maximum 1-year RRSP contribution made under the mixed salary dividend option. Growth of 6% before tax and 4% after tax for non-tax-sheltered investments were assumed.

Comparative Analysis of Dividend Only Income VS. Blended Dividend Salary Mix  For 45-Year-Old Incorporated Professional

E&OE

Salary Dividend Mix Provides A Better Outcome

If you are planning for future retirement, a salary dividend mix provides a better outcome. Drawing only dividends does not create the earned income required for you to take advantage of registered retirement savings programs such as RRSPs, DPSPs or IPPs. You also do not get the benefit of the CPP, which while not large, does have real future value with its life-time guaranteed inflation adjusted income. When you combine the impact of more invested dollars with higher rates of compound growth (due to tax sheltering), additional CPP value and less tax, you get a lot more future value to spend in retirement.

As for my friend, he is more focused on purchasing his first home than retirement, so he is still pursuing a dividend only strategy.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction. Neither Brendan Greenwood nor Pelorus Transition Planning Inc. or its affiliates provide tax, legal or accounting advice. This material is based on the perspectives and opinions of the writer only and does not necessarily reflect views of  Pelorus Transition Planning Inc. The opinions or analyses expressed herein are general, and do not take into account an individual’s or entity’s specific circumstances. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Investments are provided through Worldsource Securities Inc., sponsoring investment dealer and Member of the Canadian Investor Protection Fund and of the Investment Industry Regulatory Organization of Canada.